Coronavirus

As tempting as it might be to view the coronavirus outbreak as an opportunity to short China, we believe that the impact is best traded as a global phenomenon. Moreover, we prefer to look for trades directly linked to the epidemic, rather than broadly bearish trades.

We expect the initial impact to be felt sharply in global supply chains. Car companies and their suppliers and electronics manufacturers with extended and complex supply chains are particularly exposed, though we recognise that other globalised chains like fast fashion will also be vulnerable. We have selected a global auto manufacturer and an electronics giant as candidate shorts, as they have particularly global and complex supply chains.

Because those companies with the most exposed supply chains are also the companies that have most prepared for the risk of disruption, we think it possibly that they will implement recovery strategies and restructure their supply chains more rapidly than some expect. Thus, we like adding other coronavirus exposed names to our diversified basket.

Cruise operators are obviously vulnerable, as are airlines and airport operators.

We believe the travel and leisure industries will be severely impacted by the virus. Non-essential gatherings will likely be avoided, by choice if not by government mandate. Cruise operators are obviously vulnerable, as are airlines and airport operators. Hotel chains, resorts and theme parks will likely see substantially fewer visitors, and the travel related e-commerce sites that feed these venues will also struggle. We have selected certain airlines for their exposure to global air travel and relatively rich valuations. We have also identified a hotel chain, a theme park operator and a global online travel firm specifically vulnerable to travel disruptions.

We believe that the psychological impediments to “discretionary communal” activities like vacations and travel could persist longer than the economic disruptions from supply chains. Manufacturers will implement strategies as quickly as possible to maintain production while mitigating the risk of contagion, while families will simply choose not to book the vacation until they “feel” safer.

Commodities were early casualties of the virus, and crude oil in particular is likely to continue to struggle if our expectations for weaker demand for travel come to pass.

We favour targeted shorts on those equities most exposed to the virus.

We recognise that there is a tail risk that the epidemic results in a broad and severe blow to the global economy and financial system. Most worrisome would be the risk that the crisis results in a wave of bankruptcies that pressures financial systems, potentially leading to a systemic crisis not unlike 2008. The regulatory measures of the past decade have greatly reduced vulnerability in most markets, but the shadow banking system in China is particularly difficult to measure and regulate, and thus particularly vulnerable. We think it is premature to trade this kind of macro and systemic risk, which is way we favour targeted shorts on those equities most exposed to the virus.

It seems extremely likely that there will be a concerted global economic policy response to the worsening epidemic, via both monetary and fiscal mechanisms. While the ability for central banks to have much impact given the already low level of rates is debatable, it is possible that further liquidity helps to cushion broader equity markets. It is for those reason that we prefer to target those firms most directly exposed to the epidemic, rather than targeting specific China plays (such as luxury) or simply selling the broader market.

To find out more about how we are adapting our portfolios in light of the the rapid developments we are seeing on global financial markets, join us on Thursday 12 March for our market update: Coronavirus and oil.